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New Directions for the Middle East ACT Middle East - Talking Treasury

Dubai, 18 February 2010

Dr. Nasser Saidi,Chief Economist, DIFC Authority

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Agenda

The Shifting Economic Barycenter

The Challenges Ahead

Development of Financial Markets and the Role of DIFC

Globalization and its Consequences

Macroeconomic Outlook for the UAE

A Survey of Treasurers

A Historical Perspective

In the post WWII period three key events shaped thecourse of history:

1. Suez Canal crisis in 1956 => The end of European colonial era

2. Fall of Berlin Wall in 1989 => The end of Soviet Union

3. The Great Recession in 2008 => The end of US financialempire and “unipolar” world ;

We experienced a tectonic movement not a marginalchange or a temporary crisis and we are stepping intoa new world, yet to take shape

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The Implications of Globalization• Globalisation, in a deep sense, means fragmentation, reassemblingand a re-distribution of power.

• The early exegesis of globalization disseminated the illusion that itwould be a triumphal march for American values and economic power.In the end the process has ripped the seams of the countries (primarilyUS, UK) portrayed as the great beneficiaries of globalization.

• Paradoxically, so far the largest gains in relative terms have beenenjoyed by China and other Emerging Markets which were expected tobe the “targets” of the globalization, not the protagonists.

• As to the intellectual advocates of globalization under American aegis,the so called Neocons, who crafted and executed the war plans fromthe top floors of the Pentagon, today they evoke only a discreditedideology and an aura of incompetence.

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The Principle of Unintended Consequences

•Neoliberalism which sought to limit government, and reduce its role hasdelivered a bloated state in which government role is pervasive in key sectorsfrom banks to auto makers.•The State has a greater stake in the financial system than at any time in postWW II history, with no clear exit mechanism. We have Nationalisation withoutRepresentation.•A handful of financial institutions deemed Too Big to Fail have captured theState after having captured the regulators with minimal consequences forCEOs managers and Board Members that have led to the catastrophe.•New Weltanschaung: the Western-centric conception of modernisation thatshaped thinking and policymaking in much of the world over the last hundredyears belongs in history's trash heap.” John Gray.•The West will no longer be the standard or the arbiter of what it means to bemodern and advanced•Polycentric world emerging: politics, social & ethical values, economic andfinancial regulation are to be redefined

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World & GCC Economic Growth Outlook: delinking of Emerging Markets from Advanced economies

Source: IMF WEO (Jan 2010 update), REO (Oct09) , DIFC Economics

Real GDP growth (Annual change, %)2000–04

avg. 2005 2006 2007 2008 2009f 2010f

Bahrain 5.6 7.9 6.7 8.1 6.1 3 3.7

Kuwait 13.3 10.6 5.1 2.5 6.3 -1.6 3.2

Oman 3.2 4.9 6 7.7 7.8 4.1 3.8

Qatar 8.9 9.2 15 15.3 16.4 11.5 18.5

Saudi Arabia 3.7 5.6 3.2 3.3 4.4 -0.9 4

UAE 7.7 8.2 9.4 6.3 7.4 -0.2 2.4

GCC 5.8 6.9 5.5 5 6.4 0.7 5.2

2006 2007 2008 2009 2010f 2011fWorld output 5.1 5.2 3 -0.8 3.9 4.3Advanced economies 3 2.7 0.5 -3.2 2.1 2.4 United States 2.8 2 0.4 -2.5 2.7 2.4 Euro area 2.9 2.7 0.6 -3.9 1 1.6Japan 2 2.4 -1.2 -5.3 1.7 2.2United Kingdom 2.8 3 0.5 -4.8 1.3 2.7Other advanced economies 4.6 4.7 1.7 -1.3 3.3 3.6 Newly industrialized Asian economies 5.6 5.7 1.7 -1.2 4.8 4.7Emerging and developing economies 8 8.3 6.1 2.1 6 6.3 Developing Asia 9.8 10.6 7.9 6.5 8.4 8.4 China 11.6 13 9.6 8.7 10 9.7 India 9.8 9.3 7.3 5.6 7.7 7.8 ASEAN-5 5.7 6.3 4.7 1.3 4.7 5.3 Middle East 5.7 6.2 5.3 2.2 4.5 4.8 Western Hemisphere 5.7 5.7 4.2 -2.3 3.7 3.8

Emerging markets have recovered

Most indicators (trade, industrial production) rising faster than advanced countries

An Overview on Relative Recovery StrengthsGlobal Growth Indicators

Source: IMF WEO update, January 2010

Real GDP growth

The New Economic Geography

The development showed in the previous slide are part of a long trend started in the late ‘70 and accentuated in the ‘90s.TThe Global Economic Barycenter is now in South Western Siberia. Every crisis (1991, 2001) has accelerated the shift to the East, as Emerging markets have contributed 2/3 of global growth since 2002.

Source: Quah, D.“THE SHIFTING DISTRIBUTION OF GLOBAL ECONOMIC ACTIVITY” LSE Working Paper, October 2009

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The New Financial Geography•The new economic geography is reflected in the evolution of capital markets•The crisis will contribute to eradicate the hub-spoke model centred on Londonand New York giving impetus to a transition to a polycentric, spider web model

Source: Standard & Poors 9

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009(E)

World Market Cap 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%United States 46% 47% 50% 47% 45% 43% 39% 36% 31% 33% 28%Rest of Developed 46% 45% 41% 42% 44% 44% 44% 44% 41% 41% 41%Emerging Markets 8% 8% 9% 11% 12% 13% 16% 20% 28% 26% 32%BRIC 2% 3% 3% 3% 4% 4% 6% 9% 17% 15% 19%Rest of Emerging 6% 5% 6% 7% 7% 9% 11% 10% 11% 11% 13%of which GCC 0.3% 0.3% 0.4% 0.9% 0.9% 1.3% 2.5% 1.3% 1.7% 1.6% 1.2%

New Global Governance Framework

•New role of G20 and Emerging Markets: G-20 emerged as the keyeconomic grouping during the financial crisis, encompassing a wider range ofcountries including key emerging economies needed to tackle global issues,foremost the imbalances of current accounts. The G7 has been sidelined aslittle more than a coordination group in between G20 meetings.

•Developing economies have been pushing for institutional reform of groupslike the IMF, G7 and the Financial Stability Board (FSB) to incorporate the newbalance of economic power. But they need to be more proactive and shape avision for Global Governance

•Tests: what is the vision of the G20? Which countries will drive it?•Leadership: a fig leaf for G2?•Cooperation: financial stability, global warming, currency manipulatoin•Decision making method: drafting the agenda, taking decisions, sharing burden•Implementation: institutional engagement (IMF, World Bank, BIS) new actors?

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Lessons Learnt (?) from the Financial Crisis

•Contagion & Spillover effects:•Nearly two-thirds of the increased financial stress in MENA EM countriesafter the Lehman shock is attributable to direct or indirect spillovers offinancial stress in advanced economies (IMF WP/10/8, K Moriyama, Jan2010)Some Lessons:1. Strengthen Corporate Governance, Transparency & Disclosure2. Strengthen Financial Sector Regulation & Regulatory Capacity3. Design & introduce Financial Safety Net4. Strengthen Market Resilience5. Institutionalise and Build Economic Policy Capacity6. Engage in design of new International Financial Architecture, Policy &

Regulation7. Develop Local Currency Money and Debt markets

Priorities for the GCC in a Poly-Centric World

•Greater Regional Integration and policy harmonisation is required in trade,labour mobility, electricity market, environmental issues, financial regulation,statistical data•New institutional structures: ME Development & Reconstruction Bank tointervene in hotspots such as Iraq, Pakistan, Palestine, Lebanon and boostinfrastructure•GCC have to play a central role in the economic & financial integration ofthe wider MENASA region through infrastructure, their role as capitalexporters and linkages & spillover effects on labour exporting countries, asstandard setters and policy reformers•Local currency money & capital markets: it is imperative to create liquidand deep markets to finance infrastructure, mortgage market, government debt;

Public finance reform (e.g. debt management offices); monetary policyinstruments (repo auctions, T-Bills); revenue diversificationIslamic Securities Market

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Why Local Currency Market Development? Developing debt markets in local currencies would allow to:

• Deal with currency mismatching & exchange rate risk

• Provide Central Banks an effective monetary policy tool: open market operationsfeasible => help maintain an inflation target without a peg to a major currency

• Absorb volatile capital flows and reduce financial instability

• Provide institutional investors instruments that offer safe and stable long termyields in local currency

• Develop a stable source of capital to fund public and private ventures

• As a by-product, debt market would:

enhance transparency in pricing and intermediation,

facilitate constant monitoring of macro-economic expectations,

ensure disclosure of information and periodic communication regarding publicpolicies.

Local Debt Markets: Cornerstone of Development Policy

Potential drivers of MENA Debt Market:• Finance infrastructure and development projects in the region

• Corporate Debt: Well functioning debt markets will help reduce dependenceon bank finance at a time when the banking sector is in a process ofdeleveraging

• Government Debt: Diminish macroeconomic and financial vulnerabilityfrom energy price fluctuations by providing governments with an alternativesource of funding to smooth out volatile revenues

• Enable monetary policy by providing central banks with a market toconduct open market operations & control liquidity

• Mortgage Markets: cornerstone of housing finance

• Promissory Notes Market for corporate debtors discountable at the centralbank

Infrastructure and Growth• Public investments increase the competitiveness of an economy. This in

turn sets in motion a virtuous circle because higher productivity andcompetitiveness translate into higher tax revenues and in turn more publicinvestment in a mutually reinforcing pattern as it has been the case ofChina over the past two decades.

• In the process other positive spill-overs are felt in the form of learning-by-doing effects, efficiency gains in companies, human capital improvement,research and development in construction techniques, technology transfers,process innovation.

• The recent economic history of emerging markets clearly providesexamples of these positive feedbacks. It can be argued that the successstories of South East Asia, East Europe, Brazil, China and the GCC can beattributed more to public investment than to exports.

• This process is likely to continue in the foreseeable future on the wings oftwo powerful forces: demographics and urban middle class expansion in theemerging economies.

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Debt Market: Major Role in Infrastructure Financing• Infrastructure projects with predictable revenue stream over long term is suitable and

consistent with the orientation of Islamic Finance towards real underlying assets.• Flexibility to offer risk - reward structures to issuers. Financial institutions can lend

- be a partner based on a pre-specified profit sharing arrangement.• Lenders/investors can impose restrictions on unethical and speculative financial

activities by the issuer or borrower.• Encourage risk management through explicit disclosure and transparency of the

roles and responsibilities of the parties to a contract. Risks are integrated in theeconomic activities, which must generate sufficient wealth to compensate for suchrisks. Risk mitigation matrix is essential.

• Requires the financing to be channeled for productive purposes, such as financingprojects, rather than for speculative activities. The risk exposure is therefore to theproject and not to the uncertainties or activities that have no real economic benefits.

• Under the sukuk structure, an asset-backed instrument provides continuous securityto the investors. This approach discourages over-exposure of the financing facilitybeyond the value of the underlying asset, given that the issuer cannot leverage inexcess of the asset value

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Additional Policy Actions

•New institutional structures: new ME Development & Reconstruction Bank:Iraq, Pakistan, Palestine, Lebanon etc.

•GCC have to play a central role in the economic & financial integration of thewider MENASA region through infrastructure, their role as capital exporters andlinkages & spillover effects on labour exporting countries, as standard settersand policy reformers

•GCC Monetary Union necessary to Acquire Monetary Policy independenceand creation of the “Khaliji”; requires all GCC countries to participate and peg toa currency basket

•Strengthen Corporate Governance, Shareholders Rights, Transparency

•Modern framework on Insolvency, Creditor Rights, Bankruptcy Procedures

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Main Global Threats: The New Debt Trap

•A meltdown of the global financial system was avoided last year by shifting massiveprivate sector liabilities onto public institutions, i.e. central banks and Treasuries, soultimately burdening future generations.

•Growth of public debt and deficit spending (highest in peacetime) could pave the way toa virulent inflationary episode and an crippling dollar devaluation.

•A mounting risk of a sovereign debt crisis is materializing in Greece and otherMediterranean countries, but risks triggering a domino effect to the UK and the US. Inthese conditions, maintaining the high levels of public spending that social democracyrequires will be next to impossible.

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Main Global Threats: Financial Regulation Revamp

•Conflicts of interests have marred the sequence of crises in thepast decade.

•Stock analysts and investment bankers in the dot com bubble•Consultants and auditors in the corporate scandals (Enron,WorldCom, Parmalat)•Rating Agencies in the sub-prime and toxic assets debacle

•General lessons:•Markets are not self regulating and rules are rarely self enforcing•Leverage must be capped•Liquidity must be preserved•Regulation must be enforced with effective action not tick boxapproach

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Basel III

•Basel III will emerge, but not clear that it will be any more successful. New Financial &Regulatory architecture and end of hub-spoke model.•IIF Regulatory Update Jan 2010: The IIF released “Reform in the Financial ServicesIndustry: Strengthening Practices for a More Stable System” which assessed the extentto which firms have implemented recommended reforms in critical areas first identified inthe July 2008 Committee on Market Best Practices (CMBP) Final Report. The reportexamines the findings of a high-level survey by Ernst and Young of 48 banks in 20countries, including:

•Financial institutions have invested considerable resources in necessaryimprovements; significant changes are currently underway.•Strengthening risk management is a top priority - this includes the governance andmanagement of risk as well as the use of improved risk management techniques.•There is evidence of a change in culture in many firms with a shift in orientationfrom “sales-driven” to more “risk-focused.”•Firms are also making structural improvements – eg. to strengthen the roles ofChief Risk Officers•There has also been considerable progress in aligning compensation with risk.

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20.0

21.0

22.0

23.0

24.0

25.0

26.0

27.0

70.0

120.0

170.0

220.0

270.0

320.0

2003 2004 2005 2006 2007 2008 2009f 2010f

Nominal GDP

% share of GCC (RHS)

USD bn

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009f 2010f

Current a/c balance

Fiscal balance

% of GDP

100

101

102

103

104

105

106

107

108

109

110

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00

Loan-to-deposit ratio (RHS)

Broad money growth

% yoy

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

-1.5

0.0

1.5

3.0

4.5

6.0

7.5

9.0

10.5

12.0

13.5

2000 2001 2002 2003 2004 2005 2006 2007 2008e 2009f 2010f

GDP growth

Inflation (RHS)

% yoy % yoy

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UAE: Economic SnapshotGrowth & Inflation Financial Balances

Nominal GDP Money supply growth

Source: IMF. Global Insight, DIFC Economics

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UAE/Dubai: Resilient in face of global turmoil

• GCC/UAE/Dubai have weathered the global economic and financialcrisis

• Policy mix is sound: monetary easing, increased liquidity and fiscalstimulus

• Higher oil prices easing pressure on budget and current account

• UAE/Dubai benefit from strong trade links with Asia

• Expected lower growth in 2009, 1%-1.5% and lower inflation 1.5%

• Infrastructure, investment and positive demographics will remain key

• Institutional & Structural reforms required to sustain growth

• Reforms in public finance management and transparency in the useof resources are necessary to efficiently tap the financial markets

Daily QDUBA5YUSAC=R, QABUU5YUSAC29/02/2008 - 15/02/2010 (LON)

UAE still remains a large net creditor

Source: Reuters 3000Xtra 23

Abu Dhabi

Dubai

Sovereign CDS spreads

Volume: Dubai loans including Dubai World companies• Lending to Dubai peaked in 2008 when the Middle East was seen to be immune to the

credit crunch• In the last 6 years, lending to Dubai World companies totalled $42.6 bn• This made up 71.6% of all lending to Dubai in that time

Source: Thomson Reuters PLC. 24

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

2004 2005 2006 2007 2008 2009 ytd

Loan

Issu

ance

($B

ils.)

All OtherDubai World Companies

Maturities: Dubai’s loans incl. Dubai World co’s.

• Dubai has $7.3 bn of maturing loans in 2010, $3.3 bn of which are Dubai World firms

• This peaks in 2011 at $17.6bn, when Dubai World faces its heaviest maturities: $6.8bn

• Dubai’s maturing loans fall to $10.3 bn in 2012 and $4 bn in 2013

Source: Thomson Reuters PLC. 25

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

2010 2011 2012 2013

Mat

urin

g Lo

an V

olum

e ($

Bils

.)

All OtherDubai World Companies

Dubai Debt in Perspective

Total external debt stock of UAE increased from $94 bn in 2006 to $162 bnat end-2008 (equivalent to 70% of UAE’s GDP), split equally betweencommercial banks and nonbanks.

Total debt of the Emirate of Dubai, including QSEs, banks, and the publicsector, accounts for slightly more than half of the external debt of the UAE.

Overall, the UAE is in a large net creditor position of around $300 billion,equivalent to 140 percent of the projected GDP in 2009. (incl. ADIA assets)

The oil reserves of the UAE are in the range of 4 trillion USD (DIFC EconomicNote No.6 “Wealth Effects in the GCC form Energy Commodity Prices)

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Treasurers’ Strategic Priorities

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Top Concerns of Treasurers

Source: MEED Project Tracker

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Transformational Role of the DIFC

DIFC has set in place a sophisticated framework of laws, regulations andgovernance, modeled on international best practices

Provides market infrastructure for GCC bloc to emerge as economic andfinancial hub for MENASA region

Provides comprehensive platform for listing, IPOs, privatisation, projectfinance, securitisation

Lower access barriers to financial services

Lead integration of financial markets: DFM + Nasdaq-Dubai

Develop Regional Debt Market

Build payment system infrastructure for $ and Euro payments

Greater harmonization of laws & regulations across UAE and wider GCC

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Dubai’s status as a leading Global Financial CentreThe DIFC-KPMG “International Financial Centres Competitive Assessment Report” highlighted thestatus of DIFC as a leading financial centre. Overall, DIFC ranks 7th and Dubai/UAE ranks 10th

amongst the selected 15 international and regional financial centres.

Source: “International Financial Centres Competitive Assessment Report”, DIFC, Dec 09

Thank You

Men know what is happening now.The gods know the things of the future,the full and sole possessors of all lights.Of the future things, wise men perceiveapproaching things. Their hearing

is sometimes, during serious studies,disturbed. The mystical clamourof approaching events reaches them.And they heed it with reverence. While outsideon the street, the peoples hear nothing at all.

Constantine P. Cavafy (1915).